India Growth Story – A 9% Growth Miracle that Was Never Meant to Be

We, link this to the failure of the institution of parliament and judiciary in India.

As India’s electorates continues to come up with fractured mandate with every passing election, there are increasing instances of criminalization of politics since every political party aims at winning elections by hook or by crook so as to be able to have an important say in a coalition government. Declining quality of parliamentarians and focus on populism results in unwarranted and devastating state intervention, financial repression and crony capitalism.

Over-burdened judiciary (though perceived to be fair and independent) results in inordinate delay in delivery of justice, thereby failing to act as a deterrent against corrupt and unscrupulous elements.

We believe that the solution lies in ability to reign in rampant corruption. However, that’s going to be a long drawn battle and till that time expecting growth miracle would be chimerical.

Institutional Failures

The ongoing global financial crisis has shaken the confidence on the free market economy and we are experiencing increasing move toward state intervention, even among the DM countries, wherein market forces played more dominant role during the pre-crisis period. However, for many EM economies (including the BRIC economies) state capitalism has been a reality and politics plays a significant role in impacting the performance of the economy.

A dirigisme economy that is India, has failed to live upto its growth potential as the state failed to play the role of a facilitator to the extent desired. We believe that the Indian economy grows despite its politicians and not because of it. The moot point is – why has state capitalism failed to deliver in India. We would put that down to the failure of the institution of parliament and judiciary in India.

Increasing Criminalization of Politics

The parliament, an important pillar of democratic principle, has now been revealed in all its decadence in India. Over the years, Indian Parliament (also called Lok Sabha) has witnessed increasingly lesser and lesser time being spent on debates, discussions and framing of legislations that are pertinent for economic growth and social welfare. Of late, key legislations on economic reforms, restructuring of education, social welfare and other such reforms are getting stuck in an increasingly fractious and uncooperative Parliament.

Source: Lok Sabha Secretariat

We are seeing increasing instances of disruptions and forced adjournments of parliamentary sessions by the opposition parties as they vent their anger on some issue or other and try to show the government in poor light. Even the ruling government also has to share the blame for dysfunctional parliament. Lacking stomach for debate, they tend to rush through various businesses (including legislative) in the least possible time, thereby instigating disruptions.

Figure 2: Time Lost During Current Lok Sabha

The sixth session of ongoing 15th Lok Sabha, which corresponds with the winter session of the year 2010, was the worst session recorded in the history, when virtually no business could be conducted as the opposition parties held the parliament and the country to a ransom as the 2G spectrum allocation scandal broke out. Not to be outdone, the recently concluded eleventh session saw 80% of the time wasted after the parliament was adjourned sine die after the CAG came out with its report on coal block allocation. The main opposition party, the BJP, ensured that no business is conducted in the parliament post the tabling of the report, as they insisted the resignation of the Prime Minister Singh, no less, while eschewing any form of debate.Source: Lok Sabha Secretariat

The reasons for such poor conduct by the parliamentarians can be attributed to increasingly fractious nature of India’s coalition governments which has led to growing criminalisation of politics, as powerful gang lords are routinely employed by political parties to be able to win seats so as to be able to have more say within a coalition. There have been rising instances of elected representatives disclosing few assets at the beginning while their assets multiply manifold by the time their tenure at the Parliament or State Assemblies came to an end.

During the last (2009) general election, nearly a third of Indian MPs who took their seats for the first session of the new parliament had criminal charges against them.

The decadence of Indian parliament over time is a vital blow to the most important institution of democratic India. While RGE’s Quantitative Country Analytics (QCA) data does not incorporate some of the above parameters under the political risk factor, India fares poorly (not surprisingly) on factors like government effectiveness, control of corruption and peacefulness even vis-a-vis BRIC (which in itself is a poor performer as compared to other regions). However, the overall scorecard does not highlight India having a particular problem with overall parameters of political risk or governance. In fact India scores very well, in perceived deprivation. What this does indicate is that Indians think (as reflected in the Gallup World Poll) that their lives in the areas of healthcare, living standards, education, safety and material well-being are better than others in objective terms. Hence, despite India’s political system being highly corrupt, it successfully achieved the allegiance of the wider society, so there is little pressure for the political changes that would be necessary as a first step towards addressing India’s economics problems.

Figure 5: India vis-a-vis the BRIC Countries (as of June 2012)

Source: QCA[2]– RGE

Figure 6: Various Regional Averages (as of June 2012)

Source: QCA – RGE

The fractious nature of parliament and increasing corruption/criminalisation has resulted in India’s state capitalism engendering perverse incentives at the cost of economic performance.

Justice Delayed is Justice Denied

While the Indian legal system is perceived to be fair and independent, it has failed miserably in terms of speed and efficiency of delivering justice. This can be attributed to shortage of available judges to dispose off of various cases. According to the information provided by Salman Khurshid, the union minister of law and justice, as on March 15, 2012, India’s Supreme Court had six vacant posts of judges as against sanctioned strength of 31 posts. In case of high courts, the figure was as high as 270 against sanctioned number of posts (895).

As per the minister, close to sixty thousand matters were pending in the Supreme Court as on March 14, 2012 out of which a little more than fifty three thousand matters were of less than five years old. Which means, nearly seven thousand matters were pending for more than 5 years. Situation assumes disastrous proportion in the various high courts and lower courts. As per the available information, nearly 3.74 million cases were pending in various high courts (of which about 1.5 million cases were pending for more than five years old). This means that on an average every judge in India’s high court has to dispose of 2,324 cases per year. In various courts, as many as 22.1 million cases were pending (of which more than 4 million cases were pending for more than five years) as on December 2010.

While cross-country data on delay in awarding justice is not available, the overall inefficiency of India’s judicial system comes out very clearly when one compares data under ‘Enforcing Contracts’ in World Bank’s Doing Business report.

Figure 7: Enforcing Contracts

Source: World Bank

Given that the two major pillars of democracy has failed to live up to expectations, the Indian version of state capitalism has hobbled the economy while at the same time could not ensure inclusive growth – its avowed objective.

State capitalism in India has manifested itself in forms of debilitating intervention, financial repression and crony capitalism – thereby preventing the economy from achieving its true growth potential.

Selective State Intervention

One need not look beyond the plight of India’s power sector to understand the failure of state capitalism. In India, while power equipment manufacturing is virtually fully privatised and power generation is part private and part state owned, power distribution is mostly state owned. And the discoms (distribution companies) or the SEBs (Sate electricity Boards) are bankrupt. According to the Shanglu Committee report, SEBs’ cumulative losses for the five years ended FY10 amounted to INR820 billion and losses after subsidy stood at INR270 billion. In many cases, cumulative losses of SEBs are many multiples of their net worth. Bailing out the SEBs in the garb of loan restructuring is a regular feature now. Available indications suggest that India’s power ministry has sought restructuring of loans worth ~ INR 2 trillion approximately without which future power crisis cannot be averted. Apart from high T&D losses, the biggest problem for the SEBs is their inability to fairly price power (in agriculture sector, power is often made available at less than a cent per unit, if not free) constrained as they are by political interference. Populist schemes of these nature imposes severe burden on the nation’s fiscal condition.

Figure 8: Average Tariff per Unit for Agriculture and Industry (Rs. / Kwh)

Source: Planning Commission of India

Financial Repression

Recently India’s commerce minister also talked about restructuring loans to the textile sector to the tune of INR350 billion. In fact, forced debt restructuring of many loss making PSUs (Public Sector Units) is the standard practice, which allows the bankers to classify these loans as standard, thereby increasing the risk of impairment of assets in the future. Decisions by the policy makers to seek restructuring of loans as a solution to the problems faced by industries (unable as they are to address the basic concerns of the industry) can only come at the cost of the health of the banking sector, especially the state-owned ones which are more prone to arm-twisting.

Figure 9: Banks’ Exposure to Risky Sectors (%age of Total)

Source: RBI

Not surprisingly, as per the estimates made by The Economist, 93% of restructured loans are part of loan portfolio of the state-owned banks.

India’s banking and financial sector also suffers from the ill-effects of overbearing state capitalism. With the government looking to finance its fiscal deficit, and that too at low cost, the tools of monetary policy like SLA (Statutory Liquidity Ratio – a percentage of total demand and time liability that has to be set aside in the form of cash, gold or government approved securities) and CRR (Cash Reserve Ratio) are effectively used by the expenditure happy government. With an SLR of 38.5% and a CARR of 15%, more than 50% of deposits were set aside by the banks (just prior to the ushering in of the economic liberalisation) before they could lend. While the extent of financial repression was toned down by the next decade, the requirements are still too high for the system to be more efficient. However, it is worth noting that such high requirements can make the system stable as these can act as a cushion which the banks can theoretically draw in case there’s an NPL crisis.

Figure 10: Deposits

Source: RBI

Also, the nature of financial repression in India has evolved from traditional controls and directed lending to more innovative measures.

While, directed lending to specific sectors especially in the form of priority sector lending (which is heavily skewed toward agriculture and is among the largest sources of NPA and restructured debt for the banks), the government has been misusing its power to force state-owned institutions to take decisions much against their own business interest. A few examples will help explain this.

In February 2012, state-owned Life Insurance Corporation of India (LICI – the largest insurance company of India) agreed to pick up a 5% stake in a few state owned banks like Punjab National Bank, Central Bank of India and Indian Overseas Bank, for ~ INR37 billion. In March, Dena Bank allotted preferential shares to LICI amounting to INR1.51 billion. This had to be resorted to, as the cash strapped government was not in a position to meet the growing capital requirements of these banks.

The government has even arm-twisted India’s insurance regulator IRDA (Insurance Regulatory and Development Authority) to allow LICI to exceed the cap of 10% that an insurance company can own in any listed company. The aim is clearly to ensure that when the government gets into disinvestment mode, they can always fall back on LICI to ensure success of the disinvestment process.

Crony Capitalism

Some recent reports by the Comptroller and auditor General of India (CAG), brings forth the extent of crony capitalism in India. In case of the cola block allocation report, they found extensive evidence of misuse of political power to allot coal block to the relatives and cronies, most of whom did not have any technical expertise to operate coal mines. Even India’s Supreme Court could not help ask, “is it a mere coincidence that so many politicians, their relatives or supporters were benefited in the 194 coal block allotments.”

In case of allocation of 2G spectrum, the CAG audit found out that the then telecom minister A Raja modified the conditions for awarding license so that only some select group of operators (who paid kickbacks to front companies of Raja and his relatives as a quid pro quo) gets the licences. Incidentally, it is the same A Raja, who precipitated the decline of another state-owned telephony giant BSNL by preventing the company from expanding, while other private sector players continued to increase market share at the expense of BSNL.

The plight of India’s national carrier Indian Airlines (IA) is another such example. In 2005, the then Air India chief sent a letter to the then Cabinet Secretary complaining about the immense pressureput on the board of the airline by the then Aviation Minister. The Minister forced purchases of more aircraft than was necessary, prevented IA from flying on viable routes so that some private sector players can benefit and even took decisions that favoured a particular aircraft manufacturer.

Looking ahead

Clearly, India’s politics and policy making leaves a lot to be desired. Fractured mandate (as in the case coalition politics) and increased criminalisation goes hand in hand. Instances of corruption at high levels are on the rise. For every A Raja (2G spectrum allocation scam) or Reddy brothers of Bellary, Karnataka (mining scam) who are implicated, there are many unscrupulous politicians who roam around scot free and these include even leaders of various national parties. Since corruption cuts across party lines, there is even less incentive to nail the culprits. Political pressure ensures that law fails to run its own course. Also, given the legendary delays by the Indian judicial system in meting out of justice, the problem gets exacerbated. As the fear of law diminishes, demonstration effect of successfully corrupt politicians ensures that the tentacles of corruption spread far and wide. Unfortunately for India, while the politicians fail to do their job and effectively deprive the majority of citizens off the basic standards of living, India’s score on perceived deprivation is highly favourable. This means that corruption is generally taken into stride by the people in general and also explains why corrupt politicians get re-elected because they are adept at playing the populist game along with issues like caste and religion.

What this means is that, India’s political system will continue to remain corrupt for times to come. India’s perceived growth miracle was on the expectation that private sector efficiency will ensure triumph of free-market capitalism over barriers created by state capitalism. Clearly that has not materialised and state capitalism will continue to be an impediment. Although it is much less pervasive now than it was prior to 1991 when economic reforms were ushered in, it still has an over bearing presence. This also explains why relevant reforms take place only in fits and starts. The recently announced reforms like allowing FDI in multi brand retail and civil aviation sector, increase is diesel prices etc in another such example. The ruling government finally acted as the economy is courting crisis and sovereign downgrade was looming large. For sure, few more reform measures may well be taken, in case the government survives. But these will just be mood changers and not game changers. These anti-populist measures are also a way a deflecting popular debate away from the series of corruption that the government finds itself in.

In a developing economy like India, free-market economy and state capitalism will have to co-exist to ensure inclusive growth. However, for state capitalism to play a constructive role, the evil of corruption has to be confronted with increased accountability. On the positive side, there is an increased awareness and public movement against corruption. The media is also playing a more fruitful role in increasing awareness about corruption in India and this can lead the average Indians to have a more unfavourable view towards perceived deprivation and, thereby hopefully, strengthen the move towards reduction in corruption. This, however, is going to be a long drawn battle. Till that time, there will continue to be talks about miracle that was never meant to be.

[1] The current Lok Sabha is the 15thLok Sabha, which is scheduled to run from 2009 till 2014 i.e. the period for which the UPA will govern the country. Three sessions are held every year viz. Budget session, monsoon session and winter session. In effect 15 sessions will be held during the period. This data is till the budget session of 2012

[2] Quantitative Country Analytics (QCA) assesses sovereign risk and investment attractiveness across 174 countries by taking the most holistic approach among cross-country models known to date. Rather than relying on subjective judgments, QCA employs a totally consistent and systematic approach, using a set of standardized algorithms that reflect expert judgment and the latest academic literature.